Roth 401K v. Traditional 401K? Mega backdoor Roth??

Obviously the Roth IRA is the best that we all love but a measly $6k annual contribution doesn't give much.

Any preferences or advantages on a Roth or Traditional 401K? Leaning more towards the Roth 401K because I think that at least gives me the flexibility to withdraw my contributed principal anytime penalty free like a Roth IRA if I'm not mistaken?? That flexibility and freedom really does matter to me.

Also heard about a "mega backdoor Roth" that let's you contribute up to 38.5k annually into a Roth IRA but not exactly sure how it works. I obviously already do the regular backdoor for my 6k annual Roth IRA that's very simple. 

I suppose this will fall into a discussion about US Politics and whether taxes will be higher 30+ years from now...any thoughts? 

 
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Roth IRA Backdoor lets you contribute the amount of $58,000 (typically varies +/- 1000 depending on IRS guidelines) - 401(k) contribution - 401(k) employer match - Roth IRA contribution... so should be in the ballpark of around $30,000 if you max out 401(k) and Roth (can vary depending on if your employer contributes or not).

Probably the best way to approach this is to maximize your traditional 401(k) so you get $19,500 in tax deductions + $12,500 in standard deduction to bring down your taxable income. I did the math and it saved me something like $4,000 in taxes by maxing the 401(k) first instead of doing $0 in 401(k) and putting it all into a Roth backdoor, which doesn't seem that much but it summed up to $10,000 with employer 401(k) match.

If you do a Backdoor and skip the traditional 401(k) you are potentially leaving about $10k on the table due to a higher tax bill and no employer match. So I think it's best to do a 401(k) first and if you have extra money you'd like to invest, absolutely do the backdoor method as opposed to opening a taxable brokerage account.

But, in the long term, that tax-free return on $19,500 or whatever you put in your 401(k) will definitely yield a better overall investment return, so I guess it depends on your time horizon and whether you want the extra saved 10k in money now (do 401(k)) or want to invest from a long-term perspective.

 

Thank you a lot for this post. So I do not have an employer match at all this first year and have already maxed my brokerage Roth IRA for the 6k. Would you still recommend to do the traditional rather than opt for the Roth 401K? Guess I'm just a little confused on how maxing out the traditional 401k to 19.5k would allow you to backdoor more into the Roth afterwards?

 
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Thank you a lot for this post. So I do not have an employer match at all this first year and have already maxed my brokerage Roth IRA for the 6k. Would you still recommend to do the traditional rather than opt for the Roth 401K? Guess I'm just a little confused on how maxing out the traditional 401k to 19.5k would allow you to backdoor more into the Roth afterwards?

To do a mega back door Roth IRA you need a 401k provider that allows after tax contributions.  I believe Roth 401k contributions still get counted against the 19k limit.  

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In your situation, you would really only benefit from the reduced $4k or so in taxes if you were to maximize your 401(k) instead of dumping money into a Backdoor Roth. Personally, I am pretty frugal and looking at investments through a long-term perspective (hoping to withdraw at 55 or so) so I end up max'ing 401k, Roth, and Backdoor Roth. 

In your situation, I think it's probably best to just do a Backdoor Roth since the taxable income reduction benefit of a 401(k) is relatively minimal compared to a guaranteed tax-free investment return. Assuming you are deciding between max'ing the 401(k) with $19,500 ,,, this means you would dump $19,500 into a Backdoor Roth.

On your second question, yes, maxing the traditional 401k to 19.5k would allow you to still backdoor more into the Roth. But once again, refer back to my formula above. If you max your 401k, you will be able to contribute a lesser amount to the backdoor roth.

For example, if you max out Roth and 401k with no employer match: $58,000 - $19,500 (401(k)) - $6,000 (roth) = $32,500 you can backdoor versus not maxing 401k.... 58k - 6k = $52k you can backdoor roth.

And as per how to do this, after you max out your roth, just deposit the money you would like to backdoor into a traditional ira account then transfer it into your roth (probably should google this bc its tad bit technical setting up).

I'm also not an investment professional, so take my knowledge/advice with discretion. Regardless, as long as you're investing - 401k or backdoor - you will be fine and it's great you are thinking about this already. 

 

After the match, isn't it better to use a traditional brokerage over a traditional 401k because even though the 401k would reduce your taxable income, then distribution later will be taxed as ordinary income rather than getting the benefits of long term capital gains rates, which seems like it would have a bigger effect than the tax deferment. Am I missing something? I also have an option between a traditional and Roth 401k and am leaning towards Roth just to have tax diversification with my regular brokerage investments by retirement time. Any thoughts?

 

This is pretty much exactly what I'm wondering now...also leaning towards that roth 401k, but I have a lot of income from earlier in the year and I'm not sure if the traditional 401k would just be better to reduce my taxable income. Roth 401k surely make thing simpler though in terms of converting to a roth ira later on and withdrawing contributions early on if you wanted.

 

It’s not a question of paying either capital gains or income tax. If you put money in a normal brokerage, you’ve already paid income tax then will pay capital gains when the time comes. 

 

Also going to have to make these decisions too soon. Seems like consensus and general knowledge lends itself towards meeting company match, then max roth ira then back to maxing 401k (traditional or Roth). At what point would one start switching to using a traditional over a Roth? Because already the tax bracket analysts are in is pretty high.

 

yes this why I'm having trouble with the decisions here as I have no match this year to begin with and already did the 6k roth ira max, so now I'm unsure which one to contribute too. I have a lot of income from earlier in the year and I'm not sure if the traditional 401k would just be better to reduce my taxable income. Roth 401k surely make thing simpler though in terms of converting to a roth ira later on and withdrawing contributions early on if you wanted.

 

I wrestled with this for a bit and decided to do Roth IRA and Roth 401k. A few things to think about:

1) It’s essentially a bet on whether you’re at a higher tax bracket now or in retirement. We are at the start of our careers and likely at the lowest bracket for the foreseeable future. Even in retirement, if you’re bullish on yourself, I would anticipate a higher income / bracket from investment income. Also, look at the historic high and low brackets—we are at one of the lower points in history. 
 

2) Your preference may change over time. Once you get in or near the top bracket, it makes sense to lean more toward traditional. 
 

3) Even if your contribution is in Roth, your match will be in traditional. 
 

4) You can try to do some math and model out what makes sense all you want. Unlikely that many of the assumptions will actually be accurate. However there’s some peace of mind to think about having a Roth, where the full balance you see is what you could actually withdraw. 

 

Thank you for this. So I do not have a match at all but also did make a good bit of income earlier this year from realized short term gains so I'm honestly not sure if my tax bracket will be in a higher tier as I'm older. In fact, I think it will surely be a lower than this year if I continue banking these next few years which is a tricky situation.

However, you bring up a very important point that needs more discussion here I believe on if the tax percentages themselves within brackets will be higher in a decade or not. Also not sure if you had any thoughts on the ability for rollovers into a Roth IRA? I want to be in the position to withdraw my principal contributions in a decade or so penalty free for certain business projects and I know that is only possible  in a roth ira I believe.

Therefore, I am in a tough position where on one hand I benefit greatly from the tax deduction of traditional but roth gives that more flexibility that I'm looking for....

 

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